Glossary

8.4 Regulation and supervision of international banks

3 min read•july 24, 2024

International banking regulation is a complex web of rules and bodies designed to maintain global financial stability. The , , IMF, , and IOSCO work together to set standards and monitor the financial system.

The have been pivotal in shaping banking standards. These agreements have evolved from to , introducing stricter capital requirements, risk management practices, and liquidity standards to make banks more resilient to financial shocks.

International Banking Regulatory Framework

International banking regulatory bodies

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  • Basel Committee on Banking Supervision (BCBS) formulates global banking standards and develops guidelines for bank promoting cooperation among national bank supervisory authorities (Bank for International Settlements)

  • Financial Stability Board (FSB) monitors global financial system and coordinates international standard-setting bodies addressing vulnerabilities affecting financial systems (G20 countries)

  • (IMF) conducts surveillance of member countries' financial systems and provides technical assistance to improve financial sector policies offering financial support to countries facing balance of payments difficulties (Special Drawing Rights)

  • World Bank supports financial sector development in emerging economies and provides advisory services on banking regulation and supervision conducting assessments of countries' financial systems (Financial Sector Assessment Program)

  • (IOSCO) sets standards for securities regulation and promotes investor protection and market integrity addressing systemic risks in securities markets (Objectives and Principles of Securities Regulation)

Basel Accords and banking standards

  • Basel I (1988) introduced minimum capital requirements for banks and established (RWA) concept setting minimum capital ratio at 8% of RWA

  • (2004) introduced three pillars: minimum capital requirements, supervisory review, and market discipline refining risk measurement approaches and expanding coverage of risk types (credit, market, operational)

  • Basel III (2010) increased minimum capital requirements and introduced to complement risk-based capital measures implementing (LCR) and (NSFR)

  • Impact on capital adequacy improved loss-absorption capacity of banks through higher quality and quantity of regulatory capital enhancing resilience to financial shocks ()

  • Impact on risk management led to more sophisticated risk measurement and management techniques with greater emphasis on and scenario analysis improving disclosure and transparency of risk exposures ()

  • Impact on liquidity requirements ensured banks have sufficient high-quality liquid assets through LCR and promoted longer-term funding stability with NSFR reducing reliance on short-term wholesale funding (30-day stress scenario)

Challenges and Effectiveness of International Banking Regulation

Challenges of cross-jurisdictional regulation

  • allows banks to exploit differences in regulations across jurisdictions shifting activities to less regulated markets (offshore financial centers)

  • Divergent national interests result from varying economic priorities and policy objectives among countries leading to conflicting approaches to financial sector development (ring-fencing of capital)

  • Legal and institutional differences stem from diverse legal systems and regulatory structures with varying levels of supervisory capacity and resources (common law vs civil law systems)

  • Cross-border coordination faces challenges in information sharing among supervisors and difficulties in coordinating crisis management and resolution ()

  • Implementation timelines vary due to inconsistent adoption of international standards and varying speeds of regulatory reform across countries ()

  • Compliance costs create disproportionate burden on smaller banks and emerging markets potentially impacting competitiveness and market structure ()

Effectiveness of global banking regulations

  • Improved bank resilience through higher capital and liquidity buffers enhancing ability to absorb losses during stress periods ()

  • Reduced by identifying and monitoring systemically important financial institutions and improving cross-border cooperation in crisis management ()

  • Enhanced transparency through increased disclosure requirements and improved market discipline via better information ()

  • Limitations in crisis prevention persist due to inability to completely eliminate financial cycles and bubbles and challenges in addressing shadow banking and emerging risks ()

  • Regulatory complexity creates potential unintended consequences of complex rules and difficulties in assessing cumulative impact of multiple regulations ()

  • Macroprudential policy framework developed tools to address system-wide risks but faces challenges in calibrating and implementing macroprudential measures ()

  • Global financial stability improved through coordination via international forums (G20, FSB) with ongoing efforts to address gaps in the regulatory framework (resolution regimes for global banks)

Key Terms to Review (29)

Basel Accords: The Basel Accords are a set of international banking regulations developed by the Basel Committee on Banking Supervision to enhance financial stability by setting minimum capital requirements and risk management standards for banks. These accords are significant as they aim to ensure that banks hold enough capital to absorb losses, thereby promoting a stable banking environment which is crucial for the functioning of international financial markets.
Basel Committee: The Basel Committee on Banking Supervision (BCBS) is an international body that formulates broad supervisory standards and guidelines for banks globally. Established in 1974, its primary purpose is to enhance financial stability by promoting sound banking practices and improving the quality of bank supervision. The committee plays a critical role in the historical development of international financial markets, regulation and supervision of international banks, and international policy coordination amidst financial conflicts.
Basel I: Basel I is the first international standard for bank capital requirements, established by the Basel Committee on Banking Supervision in 1988. This framework aimed to create a uniform set of regulations to ensure that banks maintain adequate capital to cover their risks, promoting financial stability across the global banking system. By focusing on credit risk and defining the minimum capital ratio, Basel I set the foundation for subsequent regulatory frameworks and highlighted the importance of effective regulation and supervision of international banks.
Basel II: Basel II is a comprehensive framework established by the Basel Committee on Banking Supervision that aims to enhance the regulation, supervision, and risk management practices within banks. It builds upon the original Basel I framework and introduces more sophisticated measures for capital adequacy, encouraging banks to manage risks more effectively. Basel II focuses on three key pillars: minimum capital requirements, supervisory review, and market discipline, which collectively promote a safer and more stable banking environment globally.
Basel III: Basel III is a global regulatory framework established by the Basel Committee on Banking Supervision to strengthen the regulation, supervision, and risk management of banks. It was developed in response to the 2007-2008 financial crisis and aims to improve the stability of the financial system through higher capital requirements, improved risk management practices, and greater transparency.
Capital adequacy: Capital adequacy refers to the minimum amount of capital that a bank must hold as a buffer against risks, ensuring that it can absorb potential losses while continuing its operations. This concept is crucial for maintaining the stability and solvency of financial institutions, as it directly relates to their ability to manage credit, market, and operational risks. Capital adequacy is often assessed using ratios that measure a bank's capital in relation to its risk-weighted assets, ensuring that banks can withstand financial shocks and protect depositors' interests.
Common Equity Tier 1 Ratio: The Common Equity Tier 1 (CET1) Ratio is a key measure of a bank's financial strength, calculated as the ratio of a bank's core equity capital to its total risk-weighted assets. This ratio is critical for regulators and investors as it reflects the bank's ability to withstand financial stress and absorb losses, ensuring stability within the banking sector.
Countercyclical Capital Buffers: Countercyclical capital buffers are additional capital reserves that international banks must hold during periods of economic growth to safeguard against potential future losses during economic downturns. This regulatory measure aims to enhance the resilience of banks by requiring them to build up their capital reserves when the economy is strong, thus providing a financial cushion during adverse conditions. The goal is to promote financial stability and reduce the risk of systemic crises caused by excessive credit growth.
Cross-border risks: Cross-border risks refer to the potential financial, operational, and regulatory challenges that arise when international banks operate across different countries. These risks can include exchange rate fluctuations, political instability, regulatory changes, and differences in accounting practices, which can impact the stability and performance of banks as they engage in cross-border transactions and investments.
Financial Stability Board: The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system to promote stability. It was established in 2009 in response to the financial crisis and aims to address vulnerabilities in the global economy by coordinating among various financial authorities, including central banks and regulators, to enhance the resilience of the financial system.
Fintech: Fintech, short for financial technology, refers to the integration of technology into offerings by financial services companies to improve their use of financial services. This term encompasses a wide range of applications, including mobile banking, online lending platforms, and blockchain technologies. Fintech is reshaping how consumers access financial services and is influencing the operational practices of international financial institutions and the regulatory landscape governing banks.
Global Systemically Important Banks: Global Systemically Important Banks (G-SIBs) are financial institutions whose failure would have significant repercussions on the global economy due to their size, interconnectedness, and systemic importance. These banks are subject to stricter regulations and supervision to minimize the risk of their failure and to enhance the stability of the financial system. The identification of G-SIBs helps regulators monitor and manage potential risks associated with these large institutions.
International Monetary Fund: The International Monetary Fund (IMF) is an international organization that aims to promote global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. The IMF plays a critical role in the functioning of international finance by providing financial assistance and support to countries facing balance of payments problems.
International Organization of Securities Commissions: The International Organization of Securities Commissions (IOSCO) is a global organization that brings together securities regulators from various countries to collaborate on securities regulation and promote investor protection. It plays a crucial role in developing and implementing international standards for securities markets, ensuring that they operate fairly and transparently. By fostering cooperation among member organizations, IOSCO helps to enhance the integrity of the global financial system and improve the regulation and supervision of international banks.
Leverage ratio: The leverage ratio is a financial metric that measures the amount of debt a bank has relative to its equity capital. This ratio is crucial for assessing a bank's financial health and stability, as it indicates the extent to which a bank is using borrowed funds to finance its assets. A higher leverage ratio suggests greater risk, as the bank may struggle to meet obligations during downturns, while a lower ratio implies a more conservative approach to borrowing and risk management.
Liquidity Coverage Ratio: The liquidity coverage ratio (LCR) is a financial metric that requires banks to hold enough liquid assets to cover their short-term obligations during a liquidity crisis. This ratio aims to ensure that financial institutions can withstand significant cash outflows for a specified period, typically 30 days, enhancing overall stability in the banking sector. By promoting a more resilient banking environment, the LCR plays a crucial role in regulatory frameworks designed to prevent systemic failures.
Loan-to-value ratios: Loan-to-value ratios (LTV) measure the proportion of a loan to the appraised value of an asset, typically real estate. A higher LTV ratio indicates higher risk for lenders, as it suggests that a larger portion of the asset's value is financed through debt. This metric plays a crucial role in determining the terms of financing, impacting both borrowers and lenders in the context of international banking regulations and supervision.
Memoranda of understanding: Memoranda of understanding (MOUs) are formal agreements between two or more parties that outline the terms and details of a mutual understanding or cooperation. While they are not legally binding, they serve as important documents to clarify the intentions and expectations of the involved parties, especially in the context of international banking regulation and supervision.
Net Stable Funding Ratio: The Net Stable Funding Ratio (NSFR) is a liquidity standard established by the Basel III framework that requires banks to maintain a stable funding profile in relation to their assets and off-balance-sheet activities over a one-year horizon. This ratio aims to ensure that banks have an adequate amount of stable funding to support their long-term operations, thus promoting resilience in the financial system during periods of economic stress.
Phase-in periods: Phase-in periods refer to specific timeframes during which newly established regulations or compliance requirements are gradually implemented for financial institutions. These periods allow banks and other organizations to adjust their operations, processes, and systems to meet new standards, minimizing disruptions while ensuring a smooth transition to compliance. This approach helps in balancing the need for regulatory oversight with the practical realities of operational changes required by financial entities.
Pillar 3 Disclosures: Pillar 3 Disclosures refer to the framework established under Basel III regulations that mandates banks to publicly disclose key information regarding their risk profiles, capital adequacy, and risk management practices. This transparency aims to promote market discipline by enabling stakeholders, including investors and regulators, to assess the bank's financial health and risk exposure effectively.
Regulatory arbitrage: Regulatory arbitrage refers to the practice of taking advantage of differing regulations between jurisdictions to reduce costs or enhance profits. It often occurs when firms exploit gaps or inconsistencies in regulation, allowing them to operate under more favorable conditions, thereby influencing international capital flows, banking regulations, and global financial standards. This practice can be driven by globalization, as entities seek to optimize their financial strategies in response to varying regulatory environments.
Regulatory impact assessments: Regulatory impact assessments (RIAs) are systematic evaluations conducted to analyze the potential effects of proposed regulations before they are implemented. They help policymakers understand the economic, social, and environmental implications of regulations, ensuring that the benefits outweigh the costs. RIAs are crucial in fostering informed decision-making in the regulation and supervision of international banks, promoting accountability and transparency.
Regulatory reporting requirements: Regulatory reporting requirements refer to the obligations placed on financial institutions, especially banks, to submit detailed information to regulatory authorities about their financial condition, operations, and compliance with laws. These requirements are crucial for maintaining transparency, ensuring accountability, and safeguarding the integrity of the financial system.
Risk-Weighted Assets: Risk-weighted assets (RWAs) are a measure used to assess the risk associated with a bank's assets by assigning different risk weights to different types of assets. This concept is crucial for determining the capital requirements that banks must hold to safeguard against potential losses, reflecting the varying degrees of risk inherent in each asset type. The calculation of RWAs is central to ensuring that banks maintain adequate capital reserves, especially in the context of international banking regulations and capital adequacy frameworks.
Stress testing: Stress testing is a risk management technique used to evaluate how financial institutions can cope with adverse economic conditions or financial shocks. It assesses the resilience of banks and other entities by simulating a range of stressful scenarios, which helps regulators and management identify vulnerabilities and enhance risk management practices. This process is crucial for understanding how banks will perform under extreme stress, ensuring they maintain adequate capital levels to support stability in the financial system.
Systemic Risk: Systemic risk refers to the potential for a collapse in an entire financial system or market, as opposed to the failure of an individual entity. This type of risk arises from the interconnectedness of financial institutions and markets, where the failure of one can trigger a chain reaction affecting others, leading to widespread economic consequences.
Value at Risk Models: Value at Risk (VaR) models are quantitative tools used to estimate the potential loss that an investment portfolio could experience over a specified time period with a given confidence level. These models help financial institutions assess their risk exposure and maintain adequate capital reserves, ensuring they can withstand potential losses. VaR is particularly important in the regulation and supervision of international banks, as it aids in compliance with risk management standards and contributes to the overall stability of the financial system.
World Bank: The World Bank is an international financial institution that provides financial and technical assistance to developing countries for development projects, aiming to reduce poverty and promote sustainable economic growth. Its role as a key player in international finance connects it to global economic stability, investment opportunities, and the regulation of financial institutions.
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